The realization is setting in — the housing market faces an inventory impasse, not a demand dilemma. Existing-home sales continue to improve, up 1.6 percent over a year ago, according to the latest National Association of Realtors (NAR) statistics. Yet, as the pace of sales increases, the supply of homes for sales gets tighter and tighter.
It begs the question, where, oh where, are the sellers?
{mosads}It is important to note that the housing market is unlike most others. In housing, the seller is often also a buyer and a buyer is often also a seller. In most other markets, the seller makes the decision about supply independent of the buyer’s decision to buy. The housing market is different, as the majority of homes sold in the market are existing homes. Existing homes have homeowners living in them who are also considering what, if anything, they want to buy.
So, with prices at, or near, record levels, why aren’t more homeowners selling their homes? There are the obvious reasons, such as insufficient equity. It’s hard to sell your home when you have to bring a check to the closing table to pay off the lender, instead of receiving a check for your equity. But, insufficient equity is no longer the widespread problem it was, though it may still be a lingering problem in some of the hardest-hit markets.
Rising mortgage rates must be keeping sellers on the sidelines then. It’s true that existing homeowners who have refinanced recently with historically low mortgage rates have less incentive to sell as rates increase. That’s because they would give up the low mortgage rate on their current mortgage for a higher one on the house they, in turn, purchase. This so-called “rate lock-in” effect will, all else remaining equal, make buying the next home more expensive, so it may be better to stay put.
Yet, there is one more possibility that is driven directly by the fact that the existing homeowner is both seller and buyer. In today’s market, potential home sellers face a “prisoner’s dilemma.” You may have heard this term in an economics class years ago. It refers to the situation in which rational individuals (as all homeowners are) don’t cooperate with each other, even though it is seemingly in their best interest to do so.
Consider two existing homeowners. Both want to buy a new house and move but are unable to communicate with each other. If they both choose to sell, they increase the inventory of homes to buy and collectively alleviate the supply shortage. Yet, if one chooses to sell and the other doesn’t, the seller must buy a new home in a market with a shortage of supply, bidding wars and escalating prices.
Because of this risk, both homeowners choose not to sell (non-cooperation), so neither homeowner moves to a new, more desirable home. Now, scale this scenario up from two homeowners to a whole market. If everyone sells there will be plenty of supply, but the risk of selling when others don’t produces the noncooperative outcome — everyone choosing not to sell.
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This noncooperative “prisoner’s dilemma” in the housing market today is limiting the supply of homes for sale, causing prices to escalate and reducing affordability for first-time home buyers. According to the First American Real House Price Index, the fast pace of house price growth combined with rising rates has had a material impact on affordability. In March, affordability was down 11.5 percent compared with a year ago.
How do we free the market from the prisoner’s dilemma? Supply the market with homes that don’t have homeowners in them. That’s right, new homes are the traditional source of housing supply that can’t get caught in the prisoner’s dilemma. Unfortunately, it’s not so easy.
Unlike many industries that are adopting automation, robotics and artificial intelligence, building a home does not easily lend itself to outsourcing and automation. Home building still requires manual labor as a key input into the production process. According to survey data from the National Association of Home Builders (NAHB), labor shortages cause home builders to pay higher wages in an attempt to attract labor to their projects, increase home prices, delay completion of projects, decline projects, slow the rate of accepting new orders, and make projects unaffordable.
Home builders cite the construction labor shortage as a key issue for their inability to contribute to faster overall economic growth. Lastly, even if home builders overcome the labor shortage, the regulatory compliance cost significantly increases the final price. According to the NAHB, the nationwide average regulatory cost accounts for 25 percent of a home’s final price.
Mark Fleming is the chief economist for First American Financial Corporation, a U.S. financial services company and leading provider of title insurance and settlement services to the real estate and mortgage industries.
The views expressed by contributors are their own and not the views of The Hill.